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Rare Events, Financial Crises, and the Cross-Section of Asset Returns

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  • Bianchi, Francesco

Abstract

Similarities between the Great Depression and the Great Recession are documented with respect to the behavior of financial markets. A Great Depression regime is identified by using a Markov-switching VAR. The probability of this regime has remained close to zero for many decades, but spiked for a short period during the most recent financial crisis, the Great Recession. The Great Depression regime implies a collapse of the stock market, with small-growth stocks outperforming small-value stocks. This helps to explain the cross section of asset returns when risk is priced according to a version of the "Bad Beta, Good Beta" Intertemporal CAPM that allows for regime changes.

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  • Bianchi, Francesco, 2015. "Rare Events, Financial Crises, and the Cross-Section of Asset Returns," CEPR Discussion Papers 10520, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:10520
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    Cited by:

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    2. Kent Wang & Jiawei Li & Shicheng Huang, 2013. "Bad beta good beta, state-space news decomposition and the cross-section of stock returns," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(2), pages 587-607, June.
    3. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4958-4972.
    4. Bianchi, Francesco, 2016. "Methods for measuring expectations and uncertainty in Markov-switching models," Journal of Econometrics, Elsevier, vol. 190(1), pages 79-99.
    5. Maio, Paulo & Philip, Dennis, 2015. "Macro variables and the components of stock returns," Journal of Empirical Finance, Elsevier, vol. 33(C), pages 287-308.
    6. Borovicka, J. & Hansen, L.P., 2016. "Term Structure of Uncertainty in the Macroeconomy," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1641-1696, Elsevier.
    7. Ran Lu-Andrews & John L. Glascock, 2017. "Liquidity, Price Behavior, and Market-related Events," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 43(2), pages 318-351, March.
    8. repec:wyi:journl:002153 is not listed on IDEAS
    9. John Glascock & Ran Lu-Andrews, 2015. "The Price Behavior of REITs Surrounding Extreme Market-Related Events," The Journal of Real Estate Finance and Economics, Springer, vol. 51(4), pages 441-479, November.
    10. Julio Sarmiento & Mehdi Sadeghi & Juan S. Sandoval & Edgardo Cayon, 2021. "The application of proxy methods for estimating the cost of equity for unlisted companies: evidence from listed firms," Review of Quantitative Finance and Accounting, Springer, vol. 57(3), pages 1009-1031, October.
    11. Galsband, Victoria, 2012. "Downside risk of international stock returns," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2379-2388.
    12. Huang, Wei & Liu, Qianqiu & Ghon Rhee, S. & Wu, Feng, 2012. "Extreme downside risk and expected stock returns," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1492-1502.
    13. L’Huillier, Jean-Paul & Yoo, Donghoon, 2017. "Bad news in the Great Depression, the Great Recession, and other U.S. recessions: A comparative study," Journal of Economic Dynamics and Control, Elsevier, vol. 81(C), pages 79-98.

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    More about this item

    Keywords

    Great depression; Great recession; Financial crises; Intertemporal capm; Markov-switching var;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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